What the IRS Ruling Actually Means for Bitcoin

There have been a lot of rumblings since the IRS ruling on bitcoin earlier this week. For those of you who don’t feel like sloshing through several pages of legal drudgery, a brief summary:

Bitcoin and other virtual currencies have been deemed property rather than currency, which means they will be subject to capital gains tax when they are sold.

Bitcoin ‘investors’ or holders are treated essentially like stock investors.

Similarly to stocks, the rate bitcoin is taxed will depend on how long the bitcoins have been held. If they’ve been owned for over a year, the rate is a maximum of 23.8%. If they’ve been owned for less than that, they’re taxable at up to 43.3%.

If you’re unfortunate enough to have capital losses, you can deduct up to $3,000 worth of those from your ordinary income.

If you’re mining, you’re expected to report the fair market value of the coin as of that day, and it’s taxable as gross income.

If you’re paid in bitcoin, you have to pay taxes on it with a standard W-2 (federal income tax withholding applies).

Many questions have been circulating as to what this implies exactly for the future of cryptocurrency, and how it will impact the rate of bitcoin adoption. From my perspective, the primary takeaway from the ruling is that people holding bitcoin will have to keep track of their transactions and report the capital gains on the currency from the time they acquired it to the time they made transaction.

For instance, if I purchased one bitcoin at $100 and then then used that a year later to buy a couch on Overstock.com, and by that point my bitcoin had appreciated to $500, I would have to pay a tax on the difference, in this case $400. This is a hassle. No one wants to keep track of every single purchase they make, and filing taxes is already about as much fun as stabbing yourself in the eye with a fork (which is probably why I still haven’t done it despite the rapidly approaching deadline of April 15, whoops).

Call me a starry-eyed optimist, but I’m excited anyway.

The ruling illustrates that we are approaching critical mass. By that I mean that we are nearing the tipping point at which Bitcoin will be too big to ignore or regulated out of existence. I tend to view bitcoin’s price as a long-term game and as such try not to attribute too much value to any single day’s price movement (also because I’d have to get a pacemaker, and I’m about half a century too young for that) but the market seems fairly unconcerned by the announcement. Movement has been minimal, and the little action we’ve seen has been upward. **This has changed since I originally wrote the post — but again, I view the price as a long-term gain.

I understand that for some, this is a bit of an ideological let down. At this point Bitcoin has attracted people of all political views, but it was originally very well aligned with libertarian ideals—which are of course at odds with big government, regulation etc. Realistically, however, it has always been a matter of time until regulation was put in place around it. Unless we suddenly collapsed into a state of anarchy, there is no way that the US government would permit a gigantic alternate economy to grow in parallel, organically, untouched. Failure to regulate would imply a tremendous loss of both financial and political power domestically, and from an international relations perspective likely weaken Washington’s image. It would also of course be a huge missed revenue opportunity.

** Of course there are reasons why a government might choose to keep regulations very loose or essentially non-existent, similarly to why some countries have lax tax policies, but I’m not going to delve into that here.

Finally, I’m somewhat skeptical the ruling will stand exactly as it was just announced for several reasons.

The IRS claims one of the factors contributing to the ruling of bitcoin as property is the fact that nowhere is it currently legal tender. This could change. Quick, somebody call up Tuvalu and ask them to make it their official currency! My bad jokes aside, it’s key to remember that the US is only one of many players in the bitcoin economy, and what ultimately happens in the US will probably be within the context of what other major state actors choose to do.

Assuming that people actually abide by the rule and report every transaction when they make a purchase in bitcoin, that’s a heck of a lot of a work the IRS has just created for itself. We’d then also have to assume that the IRS is able to track all of these transactions, which is questionable. Although bitcoin isn’t as anonymous as many people think, identifying participants in a given transaction can be tricky. That’s a lot of assumptions. Sifting through billions of these to verify if people are reporting every purchase seems like a task of monumental proportions, and one that is probably infeasible. Unless the IRS decides to relinquish control and just “take people’s word for it” (read: not happening), I am curious as to how exactly this would be implemented.

This week’s announcement was not an actual regulation, and includes a request for comments from the public: “…the Treasury Department and the IRS request comments from the public regarding other types or aspects of virtual currency transactions that should be addressed in future guidance.” You have several options for writing in: you can mail or literally hand-deliver a letter (what?!), or you can email them at Notice.Comments@irscounsel.treas.gov.

An interesting and much more user-friendly option would be for the IRS to enact an exception similar to that which stands for taxing foreign currency. Under this ruling, “personal transactions” are excluded from those reporting rules, and if the same were extended to bitcoin, this would remove a lot of friction from the system. I hope upcoming Bitcoin rulings trend in this direction, but it will likely be years until definitive legislation is passed on the matter.

Note : I’m no tax lawyer, so all of the above is merely my interpretation of the ruling — I recommend you check it out yourself here.